Examination of witnesses (Questions 20 - 39)
WEDNESDAY 3 JUNE 1998
MR D MACKENZIE, MR D MASSIE and MR K ROBERTS
20. Was there anything else
the Department could have done to have kept you in the bidding?
(Mr MacKenzie) Not really. No, I
do not think so.
21. Obviously not in your case because you
dropped out.
(Mr Massie) Yes, it would have been
unfair to say we have had a major setback, put the whole process
on hold, we need more time to go and reform our syndicate. They
might never have concluded a sale if they had taken that approach.
(Mr Roberts) No, we took the decision
it was something we did not want to do and I do not think having
more time would have changed that decision.
22. You do these things all the time. In
your assessment would you describe the way that the Department
handled the whole of this sale as effective in your experience
or not? What would your overall assessment be of the Department's
handling of the whole of the sale process from the things you
have seen and experienced?
(Mr Roberts) I have already answered
your question in terms of the process. They and their advisers
did a difficult job pretty well and that was our view on the process
at the time. Clearly hindsight is for others to apply. We did
not have any complaints with the job which was done during the
time we were involved.
23. Would you agree with that assessment?
(Mr MacKenzie) Yes, very much.
Mr Love
24. I want to go back to this decision in
relation to withdrawal; apart from Mr Massie, who has a different
reason. As I understand it, you knew right from the start of this
process that the ROSCOs would be privatised first and therefore
in a sense the unknown political situation was well known to you
from the beginning. The process of preparing a bid must be an
expensive operation. Why was it that you only took the decision
to withdraw at the end? What was it that changed your mind during
that process about the risks involved?
(Mr Roberts) It did not and it does
not normally work like that. There were some concerns which were
clear from the beginning of the process. We believed that we could
address these concerns satisfactorily through the due diligence
process. We ultimately could not. The reason we took the decision
late in the day was that we wanted to have as much opportunity
to analyse the information available and form the best view of
that information. Ultimately the best view we formed was that
it was not something we wanted to proceed with and there was not
a defining moment of something discovered which turned us. We
just could not get comfortable ultimately with those risks.
(Mr MacKenzie) We started off believing
that it was a relatively straightforward and simple business,
given that it had not been in existence very long. Therefore we
believed, entering into that second round, that final phase of
the bid, that we could put in a meaningful competitive bid against
the management buyout. During the process we discovered it was
more complex, the contractual arrangements were harder to understand
than we originally envisaged. It was hard for us to get a real
view of the commercial risk attached to the maintenance contracts
and as we went through that process it became increasingly clear
that without the benefit of the management knowledge we would
not be able to bid. That is why we withdrew.
25. Although there was significant risk
involved in this, as I understand it from the report in the last
year under BR profits were £330 million on a turnover of
£800 million. The level of profitability must have been available
to you under due diligence. Was the reward not up to the level
of the risk? In other words, I accept all the risk factors you
are indicating there, but there was a very significant reward
to be gained here. Did that not weigh heavily on your mind?
(Mr MacKenzie) From our perspective,
when we first bid in the first round, we took the business on
the plain facts as presented to us and took a lot for granted
and that is why we bid quite aggressively in the first round.
That took into account all the potential upside in the transaction.
The problem is for a financial buyer-and we are a financial buyer
where we rely on other people's money as well as our own, primarily
banks-banks want zero risk in the financing. They look to us to
take all the risks as the equity provider and when they sat down
with us in the second round and listened to the presentations
on the business, there were enough uncertainties in there for
them to say they were not risk takers. The risk of political change,
the risk of problems with the lease, the risk of the potential
bankruptcy of TOCs were all risks they were not going to take
and we had to take them as equity provider. That meant for us,
the way we would solve that problem, would be a reduced price.
However, it came to a stage in it where our bankers said they
could not get comfortable with this transaction so we withdrew.
(Mr Massie) The figures quoted blandly
as you do there are not necessarily an accurate reflection of
the complexities of these companies in that firstly the taxation
status of them was extremely complicated. They were not normal
trading businesses which would suffer a normal tax charge. Because
of the historic capital allowance basis the tax charge could rise
alarmingly over a number of years unless you were prepared to
commit yourself to future investment in an unknown scenario. One
was almost having to make the assumption that one would make capital
expenditure of several hundred million in future years, not knowing
who the customers will be and what the political environment will
be. On the other side you quote a headline profit figure. Again
it is not a standard trading business. There was the potential
that the income stream could just come to an end. If the contracts
were not renewed at the appropriate dates then it does not matter
what the historic business was, it was not that it would fall
but it could just simply come to an end.
(Mr Roberts) As you correctly say,
we spent a lot of time and the consortium members spent not an
inconsiderable amount of money and the mere fact that we did not
bid at the end of the day indicates we could not get comfortable
that the returns would recompense the consortium for the risks.
26. When you were putting together your
consortia, as there was a large risk/reward element within this
bidding process, did you not consider going for lenders who would
be prepared to take on a much larger risk than perhaps the banks
would? Mr MacKenzie, was that never a consideration for you? The
venture capitalists seem to have won out here.
(Mr MacKenzie) The venture capitalists
who won out had the support of management and that is the crucial
difference. They had better knowledge and understanding of the
risk. They could explain them more effectively and more convincingly
to their backers.
27. Do you think that was crucial?
(Mr MacKenzie) Yes, it was certainly
crucial to our bid. When we approached our banks, the banks we
selected for it were the ones we felt were the most sophisticated
lenders who could best understand a long-term lease-type financing.
We went to Citibank and to Chemical Bank, both of whom are leading
lenders in that sector in the US. With hindsight and not a great
deal of surprise now I suppose, they were more cautious about
the comments being made by some of the MPs about their intentions
should they win the following election.
Jane Griffiths
28. I want to return to the question of
the timetable and the fact that a lot of late information was
put in very, very soon before the deadline. Do you think this
put you at a disadvantage compared with the MEBO bidders?
(Mr MacKenzie) If you look at this
report it actually says most of the non-management bidders had
difficulty in assimilating and understanding that information
and it says the management had no trouble. I think that answers
the question.
29. You have mentioned the kinds of concerns
that you had which led you to withdraw and the concerns that your
backers had. Is there in your view anything that the Department
or their bankers, Hambros, could have done to improve matters
to allay those concerns at the time?
(Mr MacKenzie) Not really. I agree
with previous comments that in the circumstances it was a pretty
slick and well-run operation.
30. Looking in the report the case for clawback
provision is made. You said in earlier answers that you never
got to that stage of discussing clawback provisions. Supposing
the Department had put clawback provisions in at the very outset
so that they were on the table at the very beginning, do you think
that would have made a difference?
(Mr Roberts) Hypothetical questions
are always a bit dangerous but from the GATX/NatWest consortium's
perspective, we were not financial buyers. They were looking to
buy the business as a strategic investment long term and therefore,
subject to the precise terms of any clawback, since it was not
part of the business case that the businesses would ultimately
be sold, although that clearly is always a possibility in any
investment, it probably would have had a relatively marginal impact
on our interest and that is clearly a rather different perspective
than a financial buyer's.
(Mr Massie) Depending on the level,
it may have discouraged us completely. If there had been clawback
there, it would have reduced the level of initial consideration
that the Department would reach.
(Mr MacKenzie) I would have the
same answer. If you want clawback we will pay less up front.
Mr Davidson
31. May I come back to the point particularly
mentioned by Mr MacKenzie about the disadvantage you felt you
were at when the management obviously had control of all the information?
What is the answer to that for us? Is it to say that management
cannot be part of any bids in any future situation so that at
least every other bidder progresses on grounds of equal ignorance?
(Mr MacKenzie) Buyouts are gradually
changing as time goes on and as the market matures. The current
vogue and the best answer seems to be that financial buyers, people
like myself and other people who back the successful management
bids, are actually given equal opportunity to deal with the management
team so the management cannot select one single buyout backer,
that actually they can only work alongside and with all the financial
buyers on equal terms. The financial buyers are given the same
access to management, the same time to ask questions and the buyout
team cannot say they are actually working with another team and
they do not want to answer that question or, worse, they will
answer it in a way which makes you more concerned rather than
less. That is a fairly recent development and was not common practice
at the time of the sale of the ROSCOs.
32. Obviously we not only have to look at
this but draw what lessons we can for the future. Do you think
it is feasible for us to say in situations where management want
to be part of a bid which is successful that every bidder is instructed
that they have to leave a certain proportion of the cake for the
management so that the management wins whatever happens and at
least then they have an interest in all bids being successful
equally? Or is there another way of dealing with it that we ought
to be thinking of?
(Mr MacKenzie) You have to look
at every case on its own merits. In a business where the management
are fairly fresh to it, they can work equally as well with any
other financial buyer rather than picking one and selecting that
one above everyone else. The financial buyers are well used to
that today; they may not have been when the ROSCOs were sold.
They are very comfortable bidding on that basis. What it means
is they bid against each other rather than bid against other third
parties. That encourages price competition.
(Mr Massie) Mr MacKenzie is one
of the leading experts in this field and his view must have merit.
Not being a specialist who is doing this every month, I look back
on this and wonder why the management were allowed to participate
in that these three companies were artificial companies, effectively
created for the transactions with the management being set up.
It seems to me that it should have been possible to devise a structure
whereby they were given contracts for a period of time, perhaps
with a performance incentive, to complete a successful privatisation
but with no promise that they could participate in the bids, in
fact perhaps even a prohibition. I have a sneaking feeling, and
it can be no more than that, that if that structure had been set
up, which would have created the level playing ground which Mr
MacKenzie has talked about, it would have received more interest
from outside bidders. It is an entirely theoretical argument and
it is different in this situation where the companies and the
management were set up for the specific reason of privatisation
rather than a decision to privatise an existing trading business
as a whole.
33. Mr Roberts, do you have anything to
add to that?
(Mr Roberts) No; those are full
answers.
34. What did you think of the price for
which these were sold at the time? What was your initial reaction?
Did you think they went for too much, too little, or did that
seem a reasonable price?
(Mr Roberts) At the time we put
a preliminary bid in, as the National Audit Office report shows,
which was lower than the ultimately successful bids. I suspect
our price indications were rising during the due diligence process
rather than falling but my feeling at the time when the prices
were announced were that they were good prices, which, had we
placed a bid, we would probably have struggled to have matched
quite frankly. With hindsight, I could not have been more wrong,
but that was my view at the time.
(Mr Massie) Our bids would have
been there or thereabouts the prices which were achieved.
(Mr MacKenzie) I thought the bids
were, given the circumstances, not bad. I thought it was a pretty
good outcome for the vendor, given the circumstances.
Mr Campbell
35. One question about the quality of information
you received. We have heard about the restraints on time which
you had to consider the increasing amounts of information you
received throughout that process and the ability of the MEBO bidders
to understand that. How do you know that you got the quality of
information that you needed when you needed it and what safeguards
did you take rather than accepting the information at face value?
(Mr Roberts) GATX were part of the
consortium because of their experience in the US in terms of leasing
transportation assets generally and rail assets in particular
so they had an independent view for example of maintenance costs
for a fleet, which was one of the material factors that all bidders
had to consider. We used outside consultants in a number of areas,
particularly just looking at the ability to re-lease the equipment
when it came off the primary leases.
36. Did they have no criticism of the way
in which information was made available to them and the speed
with which it was made available?
(Mr Roberts) No, not at all. There
was one specific issue when I know GATX were very keen to be able
to investigate the individual maintenance history of specific
items of rolling stock, which sadly I recall the British Rail
computer was unable to produce but it was a fact rather than a
criticism of the process. That analysis just was not available.
No, clearly there was a new market in the UK, there were new risks
but we went to outside consultants where we thought it appropriate.
(Mr Massie) I clearly cannot tell
you what we were not shown because I would not know we had not
seen it. In the same way it is impossible to speculate whether
others had more knowledge day to day of the business than we did.
It seems to follow that management must have known what the future
intentions of some of the customers were. As to how we dealt with
that, like other people we hired outside consultants and we had
rail consultants and management consultants advising us on various
aspects very similar to what Mr Roberts has described.
(Mr MacKenzie) The same answer.
Chairman
37. I just want to ask a couple of questions
to clarify points you have already made. Forgive me if I am going
over the same ground again but also forgive me if it is somewhere
between theoretical and hindsight; we have no choice in this Committee
in this context but to go down that route. Mr MacKenzie you have
made clear to a couple of questioners that the non-involvement
of management was a key issue for you. Clearly the way this was
structured, it was not a level playing field in that context.
Am I right in understanding your answers to questions to imply
that the modern approach to MEBOs in this context, of making them
give even-handed support to all financial bidders, is likely to
have changed your approach had you had that mechanism in place
at the time?
(Mr MacKenzie) Yes, I believe so.
38. The next question is primarily for Mr
Massie but Mr MacKenzie might want to come in on it. You made
the comment that comments by MPs-I assume you are talking about
threats of renationalisation-could have created problems with
the investment community you dealt in. I think that was the phrase
you used. Would that or would that not have affected your decision?
(Mr Massie) I do not know because
the investor who dropped out never gave us a rational answer for
his decision to do so.
39. Mr MacKenzie, you also made comments
about the political environment in the same context.
(Mr MacKenzie) We were looking at
a situation which had a number of risks in it. If that risk had
not been there it would have improved the opportunity. We look
at risks, assess them and then put a value judgement on there
either to reduce or increase the value. A bank looks at it and
the way they deal with it is either by reducing the level of debt
or by saying they will not take that risk. The political risk
was one where they were more likely to say they were not taking
the risk, especially if they were an overseas bank who were at
the time probably the best source of finance for this type of
transaction.
Chairman: It is not often that people
in your business have publicly to come and discuss the one that
got away so we offer you particular thanks for your evidence today
and the judgements you have given us. It remains for me to thank
you very much and release you.
| 
